Tungsten — Foundations for growth in place

Established in 2012, Tungsten Corporation was listed on AIM in 2013. At flotation it had agreed the acquisition of an e-invoicing business, OB10, itself founded in 2000, and a bank. The group aimed to develop the multinational e-invoicing business network established by OB10 and to offer additional services such as data analytics and, through the bank, invoice financing to buyers or suppliers on the network. The e-invoicing activity developed and remains the core of the business while the costs associated with the bank proved onerous and in FY17 Tungsten sold it, releasing cash of nearly £30m. The trade finance offering to customers continued, initially through Tungsten Network Finance (TNF) and from this financial year through a partnership with Orbian (a well-established international supply chain finance provider), which made an initial contribution to revenue in H121.

Tungsten now has over 200 employees and offices in London (headquarters), the US, Bulgaria and Malaysia. Last year it processed 19 million transactions worth £195bn for customers, including 74% of the FTSE 100 index and 71% of the Fortune 500.

The core e-invoicing business has seen major technological changes since its foundation and is now a cloud-based, open network. The network service for buyers and their suppliers generates electronic invoices enabling automated straight-through processing. Exhibit 1 illustrates some of the functionality of the network service including the variety of invoice formats that may be submitted by suppliers (accounts receivable or AR) and the ability to use the digital information provided by the network to maximise the efficiency of invoice handling for buyers (accounts payable or AP) including meeting government requirements in multiple countries, where appropriate.

E-invoicing can reduce buyer invoice processing costs by as much as 60%1 compared with manual processing of paper while increased transparency aids management decisions; suppliers also gain in terms of efficiency and improved visibility of the status of their invoices and the expected payment date. Fraud prevention is another important benefit of adoption while governments in an increasing number of countries mandate electronic submission of invoice details to improve tax collection (Italy, Turkey and a number of countries in South America are examples, while, continuing the trend, mandatory submission went live in India in October 2020 and will have a wider scope in 2021). Tungsten enables suppliers to submit tax-compliant e-invoices in more than 50 countries.

Exhibit 2 sets out the Tungsten Network service offering showing related customer and revenue types. An important point to highlight here is the comprehensive nature of the Total AP and Total AR services that were launched in FY20. They enable handling of all invoices rather than being limited to those companies on the Tungsten network as previously; a key feature developed following a market review undertaken for the board in 2018/19.

As suggested by the table above, Tungsten Network generates most of its revenues through charging initial set-up fees, subscription fees and per transaction fees. The recurring element of fees, including buyer and supplier annual fees plus Workflow (software) maintenance fees, accounted for 54% of the group’s H121 revenue and this is not affected by near-term variations in transaction volumes. Repeatable revenue, comprising buyer and supplier transaction and archiving fees, provided a further 38% of revenue giving the total for recurring and repeatable revenue of 93%. To provide some context, total Tungsten Network revenue per transaction processed in FY20 was equivalent to c £1.90 or c 2bp of the average invoice value per transaction of over £10,000 and compares with total illustrative manual paper invoice handling costs for a buyer put at over £16.00 in the Billentis paper referenced earlier.

Tungsten has a customer base that includes leading global corporations such as Nestlé, Unilever, Mondelez International, HP, Apple and, in the government sector, the US Department of Veterans Affairs. Nearly 60% of its customers are in the US (see Exhibit 3) although the international reach of these businesses means that the underlying geographical diversity is greater. There is a broad spread by industry sector (Exhibit 4) that has been helpful in mitigating the effect of COVID-19 on transaction-related revenue.

The network has c 130 buyers and over 270,000 suppliers connected to it and, through links with other networks, is able to provide the full invoice handling capability offered by the Total AR and Total AP products shown in Exhibit 2 and highlighted further below. In terms of network revenues, in H121 buyers accounted for 42% and suppliers 58% and, based on the buyer and supplier numbers indicated above, the average annual buyer revenue is c £116,000 and for suppliers c £77. This reflects the normal pattern where large companies typically have a wide range of suppliers including both large corporations and a long tail of small companies, a proportion of which may generate little or no revenue for Tungsten.

Following a market review, the group set out a revised strategy in July 2019. The review concluded the group’s key relative strength within its industry is in processing and delivering invoices between companies and a central part of Tungsten’s strategy is to build on this through increasing connections with other platforms to facilitate processing more of a buyer’s or supplier’s invoices.

Exhibit 5 shows one analysis, from Gartner, of companies addressing the e-invoicing software market. This illustrates the different and overlapping product and service offerings of various companies and, in line with the group’s strategic assessment, highlights Tungsten’s specific focus on the supplier network segment which Gartner estimates has the potential for growth of 9–12% per annum: faster than other procurement sub-sectors.

Tungsten identifies three pillars for future success:

There are also three areas of strategic focus for management:

Reflecting the high proportion of recurring revenue (54%), Tungsten’s revenue was resilient in the face of the economic impact of COVID-19 during the six months to end October 2020; group revenue was down just 1.1% compared with H120. Excluding foreign exchange movements and the discontinued TNF activity, revenue was up 2%. Gross profit was down £0.9m or 5% reflecting the absence of a one-off bad-debt collection of £0.5m in H120 and increased commission and setup costs in H120 related to new product sales. Adjusted expenses were 4% lower leaving adjusted EBITDA down £0.2m (18%) at £0.8m.

Exhibit 7 sets out a profit and loss table comparing the results for the last three half-year periods. In addition to the comments above, we highlight a number of points from the results with percentage changes being between H120 and H121, unless stated.

Positively, reflecting the work that has been done to introduce new products and reorganise the sales function new sales billings were £2.1m (£1.7m) with five new wins for accounts payable and accounts receivable products from four new blue-chip customers (one customer is taking both products). These contracts will add recurring revenue of £0.3m per year and have a total contract value of £1.3m. Since the end of H121, there has been a further contract win from a new customer taking the year-to-date wins to six.

During the first half an accounts-payable partnership with a large US bank was established, which is due to go live soon. This is indicated to have the potential to add e-invoicing volumes of up to 2.5m (compared with the FY20 Tungsten volume of 19m) from up to 28 new buyers and 40,000 new suppliers.

The underlying efficiency benefits for customers of adopting e-invoicing continue to provide a favourable long-term industry background for the group. Following a year of significant change in FY20 as Tungsten began to implement its new strategy, the group has a reshaped sales team, a well-invested technology platform, new products that are gaining traction, an encouraging sales pipeline and has established a promising start in securing partnerships to accelerate its growth.

COVID-19 does create some uncertainty because transaction-related fees account for approximately 30% of total revenue and, as seen in the first half, transaction volumes have been affected by the restrictions required to contain the pandemic. The group expects transaction volumes to continue at a lower level for the rest of FY21. There has also been an effect on the time it has taken to sign potential clients once they have entered the pipeline. Normally this would be about 10 months but, understandably, with management facing unusual operational challenges, the decision cycle has lengthened. Although adverse for transaction volumes currently, COVID-19 and remote working are helping focus the attention of companies on the risks associated with paper invoices, which may be useful in generating increased sales prospects and prompting existing customers to adopt targets for much higher digitisation of invoice handling. Significantly, the average level of digitisation for Tungsten customers today is c 30%, so there is substantial potential to increase this, enhancing the value of the Tungsten service to customers and generating higher transaction-related and other revenues.

As noted above, there does appear to be promising momentum on new sales following the changes made in FY20. In addition to the six new contract wins mentioned, the sales pipeline is being more effectively managed (helped by investment in Salesforce software) and the current pipeline stands at 2x the level that would be required to generate budgeted revenues, which the group sees as encouraging given these prospects are more clearly defined than would have been the case previously.

Tungsten looks to partnerships to add adjacent services (such as trade finance with Orbian), to extend the reach of its network (as with Coupa and the US bank partnership), to enable it to participate in bids that require broader capabilities (full procure to pay solutions, for example) where the sale would be indirect through the procure to pay vendor. While the gross margin may be lower in these cases, the revenue opportunity would probably not be available otherwise and scale/market share gains without the requirement for significant investment would be attractive. Fortunately, Tungsten’s heightened interest in partnerships and increasing connections for its network seems to chime with an industry trend in recent years where networks are increasingly open rather than proprietary and there is a willingness to partner with specialist providers to provide specific services. Reflecting this Tungsten is seeing a number of enquiries from companies interested in working with it and a further three significant potential partnership deals are under discussion although there is no certainty on timing or completion.

In line with the November 2020 trading update, with the H121 results Tungsten guided that it looks for FY21 revenue to be similar to FY20 (£36.8m), reflecting the lower transaction volumes and longer sales cycle mentioned above. Underlying adjusted EBITDA is expected to be at least £3.2m, a result of the mix of new sales and increased costs arising from the set-up of new Total AR contracts and investment in the sales team. On administrative expenses, actions were taken to reduce costs in the first half and the group expects the programme to result in annualised cost savings of £4m in FY22. The net cash position at the end of the year is expected to be similar to the H121 level of £1m, after allowing for outflows associated with restructuring exceptional costs.

We are reintroducing estimates in this note and in Exhibit 7 set out our revenue assumptions analysed by category. For FY21 we have set revenue in line with Tungsten’s guidance, with transaction-related revenue modestly lower, balanced by new customer additions that should also be positive for subscription, maintenance and implementation revenues. We assume income from the Orbian partnership will provide a partial offset to the absence of Tungsten Network Finance income. FY22 is assumed to see a bounce back in transaction volumes as vaccines progressively contain the economic effect of the pandemic. We also expect to see a fuller benefit from the stronger momentum in sales and an increasing contribution from the Orbian partnership: the resulting overall revenue growth is 9%.

The following table shows selected headline numbers from our estimates illustrating the expectation of further EBITDA margin improvement in FY21 and FY22, a return to cash generation in FY22 and a modestly positive net earnings result in FY22. For reference our revenue and cost growth assumptions in FY22 are similar to the base case assumptions used in the Tungsten Network cash-generating-unit value in use model cited earlier.

Historically, technology investment and trading losses have absorbed cash at Tungsten but cash flows improved markedly in FY19 and FY20, although FY20 benefited from favourable working capital movements. For H121, there was a net cash outflow of £2.2m, which reflected neutral cash flow from operational activities less capital spending of £1.7m and lease payments and other items of £0.5m. As noted, FY21 net cash is expected to be £1m implying broadly neutral cash flow in H221. Beyond this, improved profitability, broadly stable capital spending and close to neutral working capital is assumed to benefit cash flow in our estimates (see financial summary for further detail).

The group has a rolling credit facility of £4m of which £2m was drawn at the half-year end. This was renewed until December 2023 on similar terms.

Among other things, our estimates are sensitive to the progression of transaction volumes, whether the positive signs regarding sales pipeline are sustained, the level of success in reaching partnership agreements and the behaviour of competitors, some of which are parts of much larger corporations or owned by private equity investors.

We use a DCF valuation model to give an indication of the discount rate implied by the market price at the time of writing, given our cash flow assumptions. Exhibit 9 shows the output from our DCF model, at a range of discount rates and revenue growth rate assumptions for FY22 to FY25. We have used a long-term growth rate assumption of 2%. The share price at time of writing (30.9p) is consistent with FY22–FY25 growth of 3% and a discount rate of just over 11%: relatively conservative assumptions. The central value, 59p, is consistent with the discount rate and revenue growth assumptions used in the base case valuation model for the Tungsten Network cash-generating unit at 11% and 8% respectively.

At 30.9p Tungsten trades on an EV/revenue multiple of 1.0x. This multiple compares with quoted peers Coupa 51.6x, Esker 11.9x, E2Open 7.4x, Bottomline 4.3x, Basware 3.9x, and Proactis 1.7x. E2Open joined this list in February 2020 when it became a listed company on the New York Stock Exchange through a combination with a special purpose acquisition company. It trades on an EV/Adjusted EBITDA multiple of 23.7x based on FY21 guidance (February year-end). In November 2018, Basware reported it had received an approach from Tradeshift that might lead to an all-cash offer of €48 per share. That would have valued Basware at approximately 5x revenue but at the end of February 2019 Tradeshift withdrew on the grounds that it was unable to proceed given capital market conditions. Outside the quoted sphere, Tradeshift itself was valued at $1.1bn in a 2018 funding round giving an estimated EV/revenue of 10x.

The diversity of product offerings in the industry could make finding a good fit between companies challenging, but consolidation is a possibility given the scale benefits and potential widening of product offering that a combination might provide and the revenue multiples cited above could provide an indicator subject to fit and potential synergies.

Leaving aside M&A potential, both current implied DCF assumptions and revenue multiple seem low for Tungsten. The valuation should appear increasingly conservative as Tungsten takes further steps in its strategy implementation.